Question

A developer plans to start construction of a building in one year if at the point rent levels make construction feasible. At that time the building will cost $1,500,000 to construct. During the first year after construction would take place, there is a 25% chance that NOI will be $185,000 and a 75% chance that NOI will be $195,000. In either case, NOI would be expected to increase at 1% per year after year one.

• How much should the developer be willing to pay for the land to get a 13% IRR?

Answer 1

Expected NOI in year 1 = 25% *185000 + 75%*195000 = 192,500

Year	0	1	2
Construction cost		-1500000
Land cost	-14076282
NOI		192500	19444425
Total cashflow	-14076282	-1307500	19444425
IRR	13.0%

NOI in year 2includes terminal value of NOI which is equal to 192,500 / 0.01 = 19,250,000

Using the Goal seek function of excel (see below), we get the land cost as 14,076,282